Bonds vs Equities: Which Is Better?

As I deal with clients and colleagues and friends, these investment questions keep on popping. Either in determining which fund to get in a UITF or in a variable unit-linked insurance. Or in deciding how to allocate their monthly contributions in a retirement scheme. Plus, other usual fund options out there just play around with various combinations of these two, hence an appreciation of their characteristics should be a good start.

I won’t tell you which one is better for you since this really depends on your risk appetite, investment horizon and investment objectives. But I can attempt to lay it out for you in hopefully simpler terms and help you out in deciding.

As a lecturer used to ask us, “Which do you prefer, lend money to a big Philippine-company to finance their operations, or own a small portion of that company?”

Bonds

Lend to them so I will feel I have more money than them.

Companies, in order to raise funds may resort to issuing bonds. The government may do so as well but let us focus here on corporate bonds. Basically, for small time players like us, this means we lend our money to these companies in exchange for a fixed interest (interest on their loan), say 6% to 10% then principal will be repaid on a given maturity date (e.g. 10 years). This interest is fixed for the life of the bond (or loan) regardless of what happens to the economy or company performance and “investors” or lenders will get the interest repayments usually monthly.

Interest will vary depending on the company’s (borrower’s) investment grade. A stable profitable company may command lower rates since they are relatively lower risk compared to a smaller new-player in the industry. The risk of this investment is primarily the inability of the company to service the interest payments and to give back your principal investment once it matures. In case of bankruptcy, bond-holders will be paid first compared to share/equity-holders. This is definitely lower risk compared to equities, but return is also confined to the lower interest rates of the issued bond.

In case you no longer want to hold on the bond anymore, then we have an exchange that services bonds, PDEX. In selling the bond though, one might suffer a gain/loss depending on the prevailing interest rate in the exchange. Of course if you’re selling a bond with 6% locked-in interest but there are 10% rated bonds in the market for relatively same investment graded companies, then you’re bond will have to be sold in a discount (cheaper) to make it sort of at par with market rates. Otherwise, market will definitely prefer the 10%.

In terms of minimum investment, this usually reaches hundreds of thousands if you go direct to bond issuers. But if via UITF, then you can get it for as low as PHP10k via Trust units in banks.

Equities

Buy a small portion of that company, even less than 0.005%.

Been talking about stocks in this site for years. Yes equities just means stocks. In short, buying equities just means you get to own a very small part of the listed companies in PSE. If they become profitable, then you will be profitable in terms of dividends (if any), or capital appreciation (rise in stock prices over time as company becomes more valuable). If not, then sorry. Consider selling the stock.

This is more risky than bonds especially if your time horizon is short (day trading, short-term trading etc). No guarantees of annual return here, there may even be times that your investments may be cut in half or more due to drop in stock prices.Investment is highly dependent on company performance as well as economic and external factors. But give it 10 years and chances are big that you’re return-on-investment on a good company equity will be better than that of a bond from the same company.High risk, high returns.

One can start for as low as PHP5k and open an online trading account to start investing in stocks. Or a UITF of PHP10k as well. Buying and selling of stocks may also be done via equities brokers. Similarly though, this is subject to gains / losses depending on the price of the stock being traded.

Your Call

So which do you prefer? Lend to a company for a single-digit but almost sure return? Or risk some more and ride the lows and highs of company performance by owning a portion of it, for a chance to have double-digit gains? Then let the big guys in management use the money lent to them by others and gain decent bigger profit margins?

No need to ask me which I prefer for my investments. My answer is obvious since I have a high risk appetite while I’m still (15+x) years from retirement.

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